Understanding Commodity Futures and Market Structures

Hard Commodities Investment Commodity Futures

As part of an institutional investment strategy, a portfolio manager is considering the addition of commodity futures to diversify the portfolio further. The manager observes the current market conditions where the demand for agricultural products is projected to rise due to a forecasted increase in global population, while at the same time, the supply of energy commodities remains constrained due to geopolitical tensions. Given these dynamics, the manager evaluates the role of commodity futures in managing expectations of price volatility and capturing potential gains from these markets.

When investing in commodity futures, several factors affecting pricing and returns need to be considered, including carrying costs, the futures curve (normal contango vs. backwardation), and the fundamentals of the underlying commodity. The manager is particularly interested in the implications of the shape of the futures curve on expected investment outcomes.

Given this context, which of the following statements about investing in commodity futures is most accurate?

In a contango market, futures prices are expected to be lower than spot prices at contract expiration, resulting in a negative roll yield.

When the futures market is in backwardation, holding futures contracts allows for capturing higher returns since the roll yield is positive.

Commodity futures help eliminate price risk completely, allowing investors to lock in prices irrespective of future market conditions.

Hint

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